Worries about rising unemployment and falling home prices prompted Standard and Poor’s analysts to downgrade the financial strength ratings of three companies that provide most of the private mortgage insurance for loans purchased by Fannie Mae and Freddie Mac.

MGIC Investment Corp., Radian Group Inc. and PMI Group Inc. have 90 days to submit remediation plans to Fannie and Freddie to detail how they will restore their ratings to "AA-" or better. The financial strength rating of a fourth company, Old Republic International Corp., was downgraded by Standard & Poor’s from "AA" to "AA-."

Fannie and Freddie require mortgage insurers to be rated "AA-" or better by at least two rating agencies, and may prohibit mortgage insurers that have been downgraded below that level by one agency from engaging in certain practices, such as offering captive reinsurance.

Although Standard & Poor’s said all the insurers subjected to ratings actions are considered adequately capitalized to meet claims on existing coverage, Fannie and Freddie must review companies with ratings below "AA-" to decide whether they are eligible to insure additional mortgages backed by the government-sponsored enterprises, or GSEs.

MGIC and PMI issued statements saying they were adequately capitalized to pay claims on existing coverage, while Radian said the company was in the process of submitting a remediation plan to the GSEs and expected to keep its standing as a “top tier” company with Fannie and Freddie.

Lenders typically require private mortgage insurance on loans when borrowers provide less than 20 percent down payments. While other rating agencies have also warned they are considering downgrading the companies affected by Standard & Poor’s actions, the GSEs may have to be flexible and allow insurers that can demonstrate they are adequately capitalized to continue writing new business.

MGIC, Radian and PMI accounted for 58 percent of the private mortgage insurance industry’s flow market share in 2007, Standard & Poor’s analysts said. Other mortgage insurers do not have the capital to absorb this volume, and "replacing the capacity provided by (these) mortgage insurers … would be extremely difficult" in the short term, analysts said.

If Fannie or Freddie decided any of the companies was no longer eligible to insure mortgages purchased by the GSEs, they would likely face further downgrades, Standard & Poor’s said.

Standard & Poor’s analysts said Tuesday’s rating actions were prompted by weaker than expected fourth-quarter results at the companies, and worsening conditions that could increase future claims.

The rating agency now expects home prices to fall 20 percent from peak 2006 levels, compared to a forecast of 11 percent price declines in November. Standard & Poor’s is also projecting that unemployment will reach 5.8 percent in 2009, close to a 6 percent threshold that analysts see as a potential trigger for "significantly higher" losses for all mortgage insurers.

In the face of rising losses, mortgage insurers have significantly tightened their underwriting standards in recent months — particularly in markets where prices are falling — further limiting opportunities for homebuyers as the credit crunch that began last year shows few signs of abating.

Radian, for example, stopped insuring loans with down payments of less than 3 percent on March 31, and will no longer insure "alt-A" stated-income, stated-asset loans after April 30. Radian is raising maximum loan-to-value ratio for condominiums or co-ops in declining markets to 90 percent at the end of April (see Inman News story).

PMI has taken similar steps (see story) and MGIC has identified 30 declining markets — including all of California, Florida, Arizona and Nevada — where 10 percent down payments are required on all loans (see story).

While those steps could dent home sales, Standard & Poor’s analyst James Brender said mortgage insures’ tightened underwriting standards are among the "long-term positive factors for the industry." In a statement explaining Tuesday’s ratings actions, Brender praised "the rigor the industry has shown in reducing its exposure to higher risk products, such as mortgages with reduced documentation or high loan-to-value ratios or to properties in declining housing markets."

Although Standard & Poor’s does not expect most mortgage insurers to return to profitability until 2010, tightened underwriting standards, greater demand for mortgage insurance, higher persistency, and lower expense ratios "could make the 2008 vintage profitable despite significant home price depreciation," the rating agency said.

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